Capital Hill

Accounting and Bookkeeping Services

Proof of intention

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The sale and purchase of residential property is an area of focus for IRD Investigators as a result of the ongoing investment in the Property Compliance Programme. A Taxation Review Authority (‘TRA’) case heard in May 2017, serves as a timely reminder for all property owners to remain aware of the tax implications that can arise from residential property sales. The case involved the purchase and eventual sale of a family home by a son who had previously been involved with other property investments.

A key criterion for determining the tax status of a property transaction rests on whether the property was purchased with the purpose or intention of resale. The intention of the taxpayer is determined subjectively at the date the property is acquired.

There are instances where taxpayers have tried to satisfy this subjective test by embellishing their future intentions to support a more desirable tax outcome. Hence, it is common to place some weight on any documentation that might also refer to a taxpayer’s future plans for a property.

In this particular case, a substantial amount of weight was placed on a diary note recorded by the taxpayer’s bank officer, accompanying the loan approval request for the property. The note recorded that the taxpayer had committed to the purchase of the property because his parents were no longer financially able to complete renovations themselves, and that he would sell the property once the renovations were completed, in order to release funds needed for his other property developments.

Due to the diary note and the taxpayer’s history of buying and selling property, the IRD sought to tax the sale of the property. But the taxpayer argued that the file note was not a true account of his intentions. He told the TRA that the bank officer was a close friend of his, a friendship that had been built over years of loan applications and property investments. This had resulted in the bank officer recording a note not of a conversation, but of a mistaken assumption about the taxpayer’s intention to resell his parent’s home.

The taxpayer asserted his true intention was to assist his parents while they were experiencing a period of financial difficulty, safeguarding the family home for the long term. This alternate set of facts was further aided by the form of the bank officer’s note – it did not refer to a specific conversation, but was written as part of the loan approval request, containing information determined relevant by the bank officer.

The process for a case to reach the TRA is lengthy and involves a significant number of steps for both IRD and the taxpayer, so IRD often only reach this point if they consider themselves to have a high chance of success. With this in mind, it must have come with considerable relief to the taxpayer when the TRA ruled in his favour, concluding that the evidence showed he did not purchase the property with the intention of resale.

The case is interesting because the taxpayer went through what would have been a difficult and stressful Investigation and then ‘Disputes Process’, due to a statement that he didn’t make and likely didn’t know existed. The lesson here is that if a property is not being purchased with a purpose or intention of resale, it could be a good idea to state that on the record through the acquisition process, rather than simply relying on that being implicit.

The business of immigration

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New Zealand’s immigration system is currently undergoing a significant overhaul, which is sure to impact many local businesses. Following the changes to Investor Category visas announced in December 2016, further changes are also proposed to the Skilled Migrant Category (SMC) visa, for implementation in August. The proposed amendments are set to ensure better outcomes for both New Zealand citizens and those who are seeking to immigrate here.

Investor visas were first introduced in 2009, resulting in over $2.9 billion invested into NZ. Generally, investors may be granted resident status if they make qualifying investments in NZ for 3 or 4 years. There are two categories – Investor 1 applicants must invest at least $10m and Investor 2 applicants must invest at least $1.5m (plus have other funds available to live on).

Currently, around two thirds of these investments are in bonds. The proposed changes, effective from May 2017, seek to change this by encouraging investment in ‘growth-oriented’ industries. The ‘growth-oriented’ list includes industries associated with equities, commercial property, new residential builds or managed funds, with the potential for others to be added in the future, decided by Government need.

If Investor 1 applicants invest upwards of 25% in New Zealand growth-oriented investments they will have more flexibility on how they can meet the minimum ‘days in NZ’ requirement for this visa type. Furthermore, Investor 2 applicants will receive a reduction in the total amount they need to invest if they are willing to invest in growth investments – a $0.5m discount to be exact. To attain this discount, investors will be required to allocate more than 50% of their total investment to growth-oriented business. They will also enjoy less restriction on how they spend their required days in New Zealand over the four year period of application, much like the Investor 1 category. The additional funding is expected to provide a boost to the economy, providing an alternative funding option for businesses that may have been restricted by lack of investment into growth-oriented ventures.

Alongside this, changes to the SMC visas are also making a splash in the business environment. Residence can be granted for skilled workers under a ‘points’ system, with points granted for various criteria including qualifications and job offers. From August, the points system is supplemented by the introduction of remuneration thresholds: jobs will need a minimum salary of $41,538 to be considered ‘mid-skilled’ – being 85% of NZ’s medium income.

More points will also be available for skilled work experience and for some post-graduate qualifications. It is hoped that this will help limit the net inflow of immigrants, whilst targeting this visa type to individuals that are skilled in their industries, allowing businesses to bring in the people and skills that are beneficial to NZ as a whole.

The Government is seeking to balance the economic growth that immigration brings along with the additional strain it places on public services and current infrastructure. Getting the right balance is a challenge, but solace can be taken from the fact that it is a sign of a strong economy. It is important that the Government continually reviews immigration policies to ensure they are attaining the correct outcomes for a prosperous New Zealand.

Taxation of insurance receipts

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New Zealand has taken a battering in recent years from major disasters including earthquakes, fires, cyclones and floods. These have caused business disruptions, devastated lands, and damaged our capital’s infrastructure and homes. Where insurance is received, a question often asked is how these receipts should be treated for tax purposes.

Whether insurance proceeds are taxable will depend on what the proceeds are received for. If proceeds are for items of a revenue nature, such as loss of profits, rents, or reimbursement of business expenses, the proceeds will generally be taxable. Receipts for income protection will also be taxable because they are typically based on loss of earnings and especially if you have been claiming a tax deduction for the premiums. Insurance proceeds for capital items such as residential properties and loss of land, will generally not be taxable, unless you are in the business of dealing in property.

Depreciable assets – compensation received for depreciable assets is treated as though the asset has been sold to the insurance company for the amount of the compensation received. If the compensation is less than the asset’s tax book value (TBV), a loss on disposal can be claimed (for assets other than a building). However, where it is more, tax will need to be paid on any gain made above TBV (i.e. depreciation recovery income is recognised). Any gain above the asset’s original cost is a tax free capital gain.

The Canterbury Earthquake – specific provisions were enacted for buildings that were damaged in the Canterbury earthquake. As a starting point, proceeds will always be taxable to the extent of the cost of repairs. This results in a net nil position for income tax purposes. Where proceeds exceed the cost of repairs (“the excess”), the tax treatment will depend on whether the property is deemed “repairable” or “irreparably damaged”.

For “repairable” property, the excess is deducted from the property’s TBV. If the adjusted TBV is reduced below zero, the negative TBV would ordinarily be taxable depreciable recovery income. This is however, limited to the lesser of the negative

TBV and the actual depreciation claimed to date and is taxable in the income year in which the proceeds are applied to reduce the TBV. Any remaining amount will be treated as a capital gain. Conversely, if the excess does not cause the adjusted TBV to become negative, the depreciation recovery income will be deferred until the property is later sold.

A property will be “irreparably damaged” if it has been rendered useless for deriving income and is demolished or abandoned for later demolition. This should be agreed with the insurer and documented in the settlement agreement. The property is treated as sold for the amount of the insurance proceeds, and re-acquired for nil consideration. Any depreciation recovery income can be deferred and offset against a replacement asset that is purchased by the 2018/2019 income tax year. The remainder will be a capital gain. The proceeds of a future sale will be all capital gain, assuming no other taxing provision applies as the property’s tax base is nil for depreciation purposes.

Targeted marketing activities

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A shared universal goal of all businesses is to maximise sales of products or services. To achieve this, business owners need to implement effective marketing strategies that focus on how to reach potential customers and make their products stand out from the competition.

We are living in an increasingly digitised age so some businesses are having to transform their traditional marketing activities. The range of choices available, from websites to social media, In-app and YouTube advertising to SnapChat, is ever increasing. Because there is more choice than ever, it can be difficult for small businesses to decide where to focus resources to engage target customers effectively and efficiently.

Businesses don’t necessarily need to engage in more marketing, but smarter marketing, with resources prioritised on targeted returns. One study by google found that an astounding 56% of digital ads are never actually seen by a single human. An ad was considered viewable if 50% of the ad’s pixels are in view for at least one second. Digital ads therefore need to be targeted to ensure they reach their potential customers. To do this, a marketing strategy needs to be integrated with sales and customer service, and about providing an experience for customers. The more knowledge that a business has about existing customer’s habits and preferences, the easier it is to target potential buyers. For example, Facebook allows you to target which users see adverts based on location, demographics, interest and behaviours. And this is more straightforward than you may think to set-up.

Content marketing can be particularly powerful, allowing businesses to respond directly to customer’s signals and respond in relevant ways. Content marketing focusses on creating and distributing relevant and consistent content to a clearly defined audience to drive profitable customer action. Put simply, it’s about providing valuable information to customers to help generate sales. For example, supermarkets are now commonly creating short videos demonstrating easy to make recipes. The videos are shown across a range of social media platforms and are easily shared. The videos allow you to click directly through to the online store and place all of the relevant ingredients into your online basket for purchase, leading to a simple sales experience for the customer.

If you are considering a similar approach as part of your marketing strategy, the most important thing is to seek compelling content that is relevant to your targeted customers. Also remember that online and social media marketing is often more effective if the content is entertaining, informative or shareable.

Going back to basics, remember that marketing needs to have a key role in your business. You need to understand your customers, and decide how to best engage with and target new customers. You don’t need to do everything, as traditional marketing such as simple word of mouth, events or print advertising might work for you. However, given the changing world we live in it is important to change and adapt along with it, but do your homework first and make sure that the path taken leads to your next customer.

The perils of a PPOA

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It is important for individuals to correctly determine their residency status for tax purposes, as a New Zealand tax resident is taxed on their ‘worldwide income’.

A person is considered to be a New Zealand resident for tax purposes if they have been physically present in New Zealand for more than 183 days in any 12-month period or if they have a ‘permanent place of abode’ (PPOA) in New Zealand. A person ceases to be a tax resident if they are physically absent from New Zealand for 325 days in any 12-month period. However, if a  person maintains a PPOA throughout the period they are absent from New Zealand, they are still considered a New Zealand tax resident.

A recent Taxation Review Authority decision has highlighted the importance of these residency rules, and in particular, the breadth of a PPOA. The taxpayer, a sea captain, had an interest in his employer’s superannuation fund, and in foreign investment unit trusts owned by him, which were all sold by August 2008.

The taxpayer was accused by Inland Revenue (IRD) of maintaining a PPOA in the income tax years ended 31 March 2005 to 31 March 2009 (inclusive), and was therefore liable to pay New Zealand income tax on his interest in the unit trusts and any deemed income under the Foreign Investment Fund (FIF) rules.

The taxpayer had been a mariner all his adult life, and under the terms of his employment, spent approximately eight months a year at sea. The taxpayer’s wife typically accompanied him at sea. In 1998 he became a trustee and beneficiary of a trust which owned a property in New Zealand. The taxpayer returned to this house at least twice a year in the years from 1998 until October 2014, when the property was sold. The TRA found this property to be a PPOA for the taxpayer, supported by the following facts:

  • The property was not rented when the taxpayer was absent from New Zealand – friends and family were able to stay on occasion but otherwise the property was available for use by the taxpayer and his wife.
  • During the tax years in dispute, the taxpayer, on average, spent three and a half months in New Zealand, with credit card statements for these periods showing daily use in the suburb where the property is situated.
  • The taxpayer’s salary was used to meet the trust’s loan obligations, pay insurances, utilities and other expenses.
  • Vehicles belonging to the taxpayer, his wife, and the trust were registered to the property during the years in dispute.
  • A SKY subscription was maintained for the taxpayer’s use when at the property.
  • The address was used for mail, including mail related to the trust’s rental properties.
  • When not at sea, the taxpayer’s payslips were sent to the property.
  • The taxpayer was registered on the Electoral Roll in 2008 at this address.

As a result, the TRA upheld the Commissioner’s reassessments for each of the 2005-2009 income tax years, to tax the taxpayer’s interest in the unit trusts and any deemed FIF income from the superannuation fund. Adding to the cost, a shortfall penalty for taking an unacceptable tax position was charged, calculated at 10% of the tax shortfall.

Provisional tax improvements

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New legislation enacted in February substantially simplifies obligations under the provisional tax regime.

Most taxpayers pay their provisional tax at three times through the course of their financial year, being the 28th day of the 5th, 9th and 13th months after their balance date. The ‘standard uplift’ method determines a person’s liability based on a prior year’s tax payable (105% for last year, or 110% for previous). The problem is that if a person’s final liability is more than the estimate, Inland Revenue will charge use-of-money interest (UOMI) on the difference (currently 8.27%).

This is a source of frustration as taxpayers are either rewarded for having a great year by being charged interest by IRD, or they have to scrutinise their own tax position as they trade through the year and make increased payments to IRD when they could be focusing on their business.

In a positive change, the UOMI rules are being amended from the 2017/2018 income year. UOMI will no longer be charged from the first two provisional tax dates on the difference between a person’s ‘standard uplift’ liability and their actual liability based on their completed tax return.

In order to defer the start of the interest charge the taxpayer must meet the minimum payment obligations under the standard uplift method on the first two instalment dates. Where the taxpayer does not make the required payments, UOMI will apply on the first two instalment dates based on the lower of the difference between: the amount due under standard uplift and the actual payment; or one-third of the residual income tax liability for the year and the actual payment.

To be eligible for the concession, companies within a group will all be required to use either the standard uplift or GST ratio method for calculating provisional tax. This rule is designed to prevent related entities gaming the differences between the standard uplift and estimation methods to reduce exposure to UOMI.

In a similarly positive change, the existing concession, which defers UOMI for individuals with a tax liability of less than $50,000 to their terminal tax date (typically the following 7 February or 7 April), is being increased and widened. From the 2017/2018 income year, the concession is being increased to $60,000 and extended to all types of taxpayers, such as companies.

As with the first change above, there are requirements that need to be met in order for the concession to apply, such as meeting obligations under the standard uplift method. IRD expects that the change to the safe harbour threshold will eliminate UOMI charges for approximately 67,000 taxpayers, at least 63,000 of these being non-individuals who did not previously qualify for the concession.

Finally, the late penalty regime is also changing. Currently, a 1% late payment penalty is charged the day after tax is due, a further 4% penalty is charged at the end of the first week and a 1% incremental late payment penalty is charged each month thereafter. For most taxpayers the incremental 1% monthly penalty will no longer be charged on GST periods starting from 1 April 2017 or income tax and working for families debts relating to the 2017/2018 or later years.

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